Best for Central Bank to Act Fast to Rein in Credit Boom, BOE Analysis Suggests

When is the best time for a central bank to step in to rein in a burgeoning credit boom? Sooner rather than later, suggests a Bank of England analysis.

The U.K. central bank on Monday published an updated version of a policy paper it first issued a year ago about its new powers to vary bank capital requirements to safeguard financial stability. The BOE’s Financial Policy Committee gained these powers in a shake-up of U.K. finance-sector regulation in April, but has yet to use them.

The power to vary bank capital requirements is an important part of many central banks’ arsenals. If banks are making too many risky loans, usually to somebody wanting to purchase real estate, then demanding banks finance those loans with more equity should discourage the greatest excesses and ensure lenders are better-equipped to absorb any losses. Regulators can apply stricter capital rules across the board or target them at a particular sector, such as mortgage lending, in pursuit of these objectives.

A new section in the BOE paper examines a range of such sectoral capital interventions in India, Brazil, Switzerland, Australia and Ireland. The conclusion is that they can be pretty effective in curbing excesses but have to carefully timed.

The paper contrasts Ireland’s failure to rein in a boom in mortgage lending to riskier borrowers in 2006 with Australia’s success in 2004. Ireland’s move to raise capital requirements was “too little, too late,” according to an analysis by Ireland’s central bank cited by the BOE, whereas Australia was more successful in discouraging risky lending by raising capital requirements as soon as concerns started to emerge, the paper says.

“Timing is critical, with the contrast between Ireland and Australia highlighting the importance of early intervention,” the paper says.

About Real Time Economics

Real Time Economics offers exclusive news, analysis and commentary on the U.S. and global economy, central bank policy and economics. Send news items, comments and questions to the editors and reporters below or email realtimeeconomics@wsj.com.